Social protection in the face of climate change: Targeting principles and financing mechanisms

Social Protection in the Face of Climate Change:
Targeting Principles and Financing Mechanisms
Michael R Carter & Sarah Janzen
University of California, Davis, I4 Index Insurance Innovation Initiative & NBER
Montana State University
June 2015
Carter & Janzen Social Protection & Climate Change

Summary
Shocks are a recognized driver of poverty
Climate change, which increases the frequency & intensity of
climate shocks, threatens to make shocks an ever more
important part of the poverty dynamics
Against this backdrop, we ask two questions:
1 How should social protection in the face of climate change be
targeted or prioritized between the already destitute and those
who are vulnerable to becoming destitute?
2 Can public budget constraints be relaxed–and impacts on
poverty increased–by having social protection targeted at the
vulnerable ﬁnanced in part by the private social protection
insurance ’premium’ contributions by its beneﬁciaries?

Summary
To gain purchase on these questions, we develop a theoretical
model of risk, accumulation and insurance inspired by pastoral
regions of East Africa where climate shocks drive poverty
Preliminary findings from the theoretical analysis are:
Targeting social protection dollars to the vulnerable reduces
both the extent and depth of poverty relative to a conventional
cash transfer strategy that targets only the destitute;
Given a budget constraint, targeting the vulnerable induces a
tradeoff between the short-term and the long-term well-being
of the poor;
Can mitigate this tradeoff if the public budget is stretched by
having the vulnerable fund a portion of the premium load for
an insurance that functions as contingent social protection;
Limited ability of the vulnerable to self-finance their own social
protection as their demand for insurance is highly price elastic
Climate change-induced increases in risk ... [still need to finish
this part!]

Outline for Today
1 A Dynamic Model of Risk, Vulnerability & Long-term Poverty
Dynamics
Core insights from a model with fixed human
capital/capabilities
Endogenous human capital formation & the inter-generational
transmission of poverty
2 Social Protection Tradeoffs: Targeting the Destitute or the
Vulnerable?
Standard social protection via means-tested CCT targeted at
the destitute
Inter-temporal poverty tradeoffs if prioritize contingent
transfers to the vulnerable over a CCT
3 Reducing Tradeoffs with Partially Self-financed Insurance
Implementing vulnerability-targeted social protection via index
insurance
Budget-stretching through beneficiary co-finance of VSP
Limitations of co-finance

Dynamic Model of Consumption & Accumulation in the
Face of Risk
Consider an infinitely lived household dynasty d, which is
comprised of a sequence of generations g = 1,2,... & each
generation lasts for 25 years (t = 1...25).
Enjoys initial endowments of physical assets (Ad0) and human
capital (Hd0)
Assets and human capital combine to produce income using
either a low or high (fixed cost) technology
Assets are subject to random depreciation (mortality) shocks
Consumption cannot be more than cash on hand (value of
income plus assets) as no borrowing is assumed possible
Initially assume human capital fixed across generations at Hdo
Will then allow human capital to be updated for each new
generation, where updating sensitive to ’childhood’ nutrition in
the prior generation
Mathematically:

Dynamic Model of Consumption & Accumulation in the
Face of Risk
max
c
−→dgt
Eθ
∞
∑
g=1
25
∑
t=1
u(cdgt)
subject to :
cdgt ≤ Adgt +f (Adgt,Hdgt)
f (Adgt,Hdgt) = Hdgt max[A
γh
dgt −F,A
γl
dgt]
Adgt+1 = f (Adgt,Hdgt)+(1−θdgt+1)Adgt −cdgt
Hdgt+1 = Hd0
Adgt ≥ 0

Dynamic Model (ﬁxed human capital)
Model admits 2 possible long-run equilibria:
For each initial endowment pair (Hd0,Ad0), there is some
probability that the dynasty will end up in ’chronic poverty’ at
the low equilibrium
Fixing Hdo at an intermediate level, simulation of the dynamic
model reveals the following:
Micawber threshold AM = 14

Chronic Poverty Map (fixed human capital)
Across full endowment space see the following:
For fixed human capital, partitions space into: Always poor
(Hd0 < 1.05); Never poor (Hd0 > 1.35); and, Multiple
equilibrium potentially poor in between
At any point in time, define the Vulnerable as those in the
multi-color band & AM(H) as the ’Micawber Frontier’

Dynamic Model (ﬁxed human capital)
Model has three key implications:
Shocks Can Have Irreversible Consequences for the Vulnerable
A shock that pushes a household below its critical asset level,
AM (Hdgt), has irreversible consequences as the household
becomes mired in chronic poverty.
Shocks Can Induce Asset Smoothing by the Vulnerable
While households near either steady state will smooth
consumption, highly vulnerable households in the
neighborhood of AM (Hdgt) will asset smooth when hit with a
shock (cut consumption to preserve capital and avoid collapse
into chronic poverty).
While asset smoothing is understandable, it potentially has
deleterious long-term consequences as consumption doubles as
investment into future human capital.

Nutritionally Sensitive Inter-generational Transmission of
Human Capital
Know that the ’First 1000 Days’ matter for human potential
Evidence that the poor households smooth by cutting
nutritional and educational investments (e.g., Hoddinott &
Kinsey, 2003, Hoddinott, 2006 & Jacoby et al. 1997).

Nutritionally Sensitive Inter-generational Transmission of
Human Capital
Consider following equation of motion for human capital:
The first term is curly brackets is the next generation’s genetic
potential expressed as a weighted average of the parent
generation’s human capital endowment and a random draw,
˜H, from the overall population capabilities distribution
(E H = 1.35 in simulations)
The second term in curly brackets is a penalty that pushes an
individual below their genetic potential if they suffered
consumption shortfalls (cdgt < z) in the first critical five years
of life.

Chronic Poverty Map (endogenous human capital)
Again simulate the dynamic model (assuming myopia), but
this time allowing human capital to evolve
(a) Fixed Human Capital (b) Endogenous Human Capital
Micawber Frontier has moved to the northeast. Initial
endowment positions in the lower right of the diagram, which
used to have some probability of escape from long-term
poverty have seen those prospects drop to zero.

Chronic Poverty Map (endogenous human capital)
Moreover, vulnerability has increased for a broad range of
dynasties that used to be able to rely on rapid accumulation
and asset smoothing to insure a near certain escape from
poverty.
Get further insight into process by looking how human capital
evolves across generations:

Poverty Dynamics under a Conventional Cash Transfer
Social Protection Policy
The inability of poor households to sustain investment in the
human capital of their children has motivated the outpouring
of ’save the children’ CCTs we now see across the world
We begin by considering a stylized social protection program
that offers cash transfers τdgt with the following
characteristics:
Means Tested: Eligible households are those for whom
cdgt < z, where z is the consumption poverty line.
Contingent Transfers: Subject to budget constraints, each
household receives the transfer needed to completely close the
poverty gap–i.e., τdgt = z −cdgt.
Government Budget Constraint: Government has a fixed social
protection budget, B, that is initially just large enough to close
the poverty gap for all destitute households. If budget becomes
insufficient, then transfers are adjusted so that all destitute
dynasties receive transfers that close an equal fraction of their
poverty gap.

Mathematically, deﬁne the total social protection need at each
point in time as:
˜Bgt =
D
∑
d=1
(z −cdgt)1(z > cdgt)
and deﬁne the available budget adequacy as:
λgt =
B
˜Bgt
.
Individual transfers are thus given by:
τdgt =



z −cdgt if λgt ≥ 1
λgt(z −cdgt), otherwise
.

To explore the effectiveness of the CCT, we use our dynamic
model to simulate an economy comprised of D dynasties that
are initially spread uniformly across the physical/human capital
endowment space
Assume CCTs are ’unanticipated’ in sense of
Barret-Carter-Ikegami
We can then see how the CCT influences the chronic poverty
map and also gauge its effectiveness via headcount and
poverty gap measures defined as follows:
Hgt =
D
∑
d=1
1(z > cdgt)
D
Ggt =
1
DHgt
D
∑
d=1
(z −cdgt)1(z > ccgt)

Chronic Poverty Map under a Budget-constrained CCT
(c) Endogenous Human Capital (d) Endogenous HK with CCT
Cash transfers have some impact on poverty dynamics as the
area of certain chronic poverty in the southeast corner of the
map shrinks modestly.
Vulnerability, however, remains high in certain portions of the
endowment space.

Poverty Dynamics under a Budget-constrained CCT
Measures based on realized post-transfer consumption
(e) Poverty Headcount (f) Average Depth of Poverty
As can be seen, cash transfers initially cut into the extent and
depth of poverty.
Over time, the poverty headcount measure drifts upwards as
shocks slowly increase the number of destitute dynasties
Given the ﬁxed budget, this increase in the number of cash
transfer-eligible households in turn pushes up the average
depth of povertyCarter & Janzen Social Protection & Climate Change

Poverty Dynamics under a Budget-constrained CCT
Measures based on potential earnings
(g) Poverty Headcount (h) Average Depth of Poverty
These measures are based on expected income (based on
assets)
More stable, but draw out that cash transfers have limited
impact on potential (except via human capital circuit)

Vulnerability-targeted Contingent Social Protection (VSP)
The pernicious effects of the underlying system dynamics
raises the question as to whether there can be a more effective
deployment of the given social protection budget
Consider a VSP scheme as one which:
Vulnerability Targeted
Issues payments to the “moderately vulnerable” (non-poor
20-80% chance of collapse into destitution) anytime they are
hit by a shock that could push them into chronic poverty (note
that these are contingent payments)
Triage
Social protection resources are triaged by first making transfers
to the vulnerable who have been hit by shocks, and then
transferring the residual social protection budget to the already
destitute.

Vulnerability-targeted Contingent Social Protection
(preliminary results)
Preliminary results
Tradeoﬀs in depth of poverty visible in poverty measures above
Also see (small) favorable shift in chronic poverty map
(i) Endogenous HK with CCT (j) Triage Remakes Poverty Map

Using Insurance Mechanisms to Reduce Targeting Tradeoff
In principal, contingent social protection is essentially a social
insurance contract that pays off in moments of need
As already seen, such insurance can break the descent into
poverty for the vulnerable
Given these large private gains from contingent social
protection, and the tradeoff implied for the poverty gap when
budget is redirected from a CCT to a VSP, might it be possible
for the vulnerable to pay for their own social protection
To explore the willingness of the vulnerable to pay for this
protection, we explore the pattern of demand for an index
insurance contract set up to mimic a CSP
In particular, will explore an implementable index insurance
contract that pays off any time a covariant shock occurs
(idiosyncratic shocks do not trigger payments, exposing the
vulnerable to ’basis risk’)

VSP as Insurance
Drawing on Janzen, Carter and Ikegami (2015), we explore the
willingness of the vulnerable to purchase insurance
Despite potential gains from contingent payments, the
vulnerable’s willingness to purchase insurance at market prices
is modest, but price elasticity is high
Pattern reﬂects extremely high shadow price of liquidity of the
vulnerable (See Janzen et al. for further details):

Evaluation of Cash Transfer & Subsidized Insurance Social
Protection Scheme
Taking the same budget constraint, government ﬁrst spends
money oﬀering a 50% insurance subsidy to anyone with less
than 35 units of assets
Residual budget spent on cash transfers as before
(k) CCT (l) Subsidized Insurance

Evaluation of Cash Transfer & Subsidized Insurance Social
Protection Scheme
Can also look at poverty measures:
(m) Poverty Headcount (n) Average Depth of Poverty

Further Insights into Efficacy of Alternative Schemes
Insurance subsidy leads to more even draw on budget
Cheaper too (but note have targeting differences)
Finally, see growth impacts of insurance (asset transfers are
unanticipated, however)
(o) Budget Remaining for Cash
Transfers
(p) Growth Effects on GDP

Shocks and Climate Change
Currently assume the following baseline distribution of
covariant risk
Currently are increasing likelihood and skewness of shocks to
gain insight into what happens under stylized climate change
scenarios

Conclusion
Weather & other shocks may be an important driver of poverty
Coping strategies of the vulnerable are partially effective in the
short-term, but may fail in the longer-term as the
consequences of reduced nutrition are transmitted through to
the next generation
Logic of contingent social protection for the vulnerable is clear:
Prevent the growth of the number of destitute (which crowds
the social protection budget & increases the poverty gap)
Reduce the inter-generational transmission of poverty caused
by asset smoothing
Insurance can in principal serve at least a partially self-financed
form of social protection for the vulnerable
Need to still flesh out the sensitivity of optimal policy to risk
environment
There are also challenges to making insurance work, but that
is a topic that merits its own discussion

Social protection in the face of climate change: Targeting principles and financing mechanisms

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Social protection in the face of climate change: Targeting principles and financing mechanisms